China brokerages in debt-selling rush to boost leverage

Chinese brokerages have borrowed nearly $13 billion so far this year by issuing debt to fund expansion after authorities opened doors to lucrative but riskier businesses, a move which could double returns to shareholders over the next three years.

Brokerages are looking to expand into proprietary trading and various lending activities, including to margin traders and short-sellers, industry executives say. They will also begin lending to enterprises, though unlike banks they will require collateral, such as shares.

Many securities firms are already involved in shadow-banking, whose off-balance sheet lending has raised anxiety over the health of financial sector. But these new activities will be all on-balance sheet, limiting the scope of any downside risks.

Last May, China Securities Regulatory Commission (CSRC) lifted a ban on brokerages issuing short-term bills and earlier this year allowed them to sell corporate bonds for the first time.

The watchdog has also drafted rules that would effectively triple the ceiling on brokerages' leverage ratio, enabling them to borrow more money to fund new businesses at a time when their traditional business areas are dwindling.

"Unlike Western banks, Chinese brokerages have long been plagued by a low leverage ratio, which has seriously curbed returns to shareholders," Li Chuqian, chief financial officer at China's second biggest brokerage Haitong Securities Co, told Reuters.

"It's imperative for us to increase mid- and long-term borrowing."

So far this year, 13 brokerages, including industry leader CITIC Securities, China Merchant Securities and GF Securities, have raised more than 80 billion yuan ($12.93 billion) from the debt market, according to Reuters’ calculation.

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More brokerages are following suit. Haitong last month unveiled plans to issue both short-term bills and long-term bonds, while bigger rival CITIC said it aims to raise an additional 40 billion yuan through bond sales.

The expansion into new businesses such as margin financing will give brokerages a much needed revenue stream after being hit hard over the recent years by a slowdown in their traditional brokerage and investment banking businesses due to a volatile stock market and a government freeze on the initial public offerings.

"The traditional business model is unsustainable," said Liu Zhihui, president of Industrial Securities Co, a brokerage seeking to grow its balance sheets using various debt instruments.

Whereas the expansion into fresh activities do not represent any systemic risk there are some concerns that brokerages could risk pratfalls in their rush for new business.

"If they run too fast without heeding risks, they would trip over," said Tian Liang, analyst at Guosen Securities. "I don't think regulators are fully ready to cope with potential risks lurking in certain new businesses."

Low leverage levels, however, will limit the risks.

CITIC Securities plans to boost its leverage ratio to more than 2.5 times from about 1.5 times currently, which is also the industry average, vice chairman Yin Ke said.

The firm's return on equity (ROE) – a measure of profit made on shareholders' investment – could double to around 10 percent in three years from around 5 percent last year, Yin added.

The move to allow brokerages to raise their leverage ratio runs contrary to what is happening in the West, where banks have slashed leverage since the 2007/08 global financial crisis.

Western banks' leverage ratios have come down from over 30 times before the financial crisis, to over 10 times. But Chinese brokerages' leverage ratios are still far lower.

"It's extremely low, to the point that equity capital is deployed very inefficiently," said Liao Qiang, analyst at Standard & Poor's Rating Services.